Bond Vigilantes Make Their Votes Known in Europe

They may have retired in the U.S., but the bond vigilantes are alive and well in Europe.

The stunning lack of interest in Wednesday’s sale of 10-year German bonds shows the so-called fire walls incessantly talked about to contain the euro-zone sovereign debt crisis are nowhere to be found. Instead, the fire blazes out of control.

As reported, Germany was only able to sell 3.6 billion euros of a planned 6 billion euros in 10-year bunds, among the safest debt on the planet. Yields had been declining in Germany as institutional investors already are ditching the IOUs of just about every other European country. Wednesday, German yields rose.

If Germany, the strongest and safest European country, now has to struggle to finance itself, the two-year-old European sovereign debt crisis has reached a new and even more dangerous phase.

Fast and significant action is needed, though the democratic systems in place in each of the affected European countries and in the still partial connection between those countries make swift and strong action extraordinarily unlikely.

“Thus the brilliant phrase, “bond vigilantes.” U.S. Democratic adviser James Carville back in the 1990s noted the power of bond types to push the government toward deficit reduction, commenting that given its power he would like to be reincarnated as the bond market.”

Probably the only reason those vigilantes aren’t also back in action in the U.S., given this democracy’s parallel inability to lay out a credible long-term deficit reduction plan, is that Europe is worse off and the money has to sit somewhere.

Markets, it has been famously said, swing between greed and fear. Fear is the stronger emotion. And while it might be prudent for each institutional investor to sell Europe now and ask questions later, just to be safe without true regard for the facts in each nation, the collective result of all those individual prudent decisions is a staggering negative.

Remember the autumn of 2008. Just as then, the collective actions of the sell Europe crowd threaten the day-to-day foundation of markets. That foundation, including the ability to roll over debt at reasonable prices, allows companies and nations to live and breathe.

There is a significant disconnect between the every person has a vote doctrine of representative government and the blunt collective power of money and markets. Most of the time this disconnect is hidden and doesn’t really matter. In times of crisis, as we have seen in Europe, it can become the only thing that matters, overshadowing coalition governments, parliamentary squabbles, constitutional prohibitions and all the rest.

The voters live here, the money doesn’t. The money can vote with its feet and the money is doing so.

Correction

An earlier version of this post incorrectly cited James Carville as having coined the phrase “bond vigilantes.” Economist Ed Yardeni is widely credited with pioneering the phrase.

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